Why Separating Personal and Business Expenses is Important

As a freelancer, you probably don't run your business like a Fortune 500 company. Most likely, you don't have regular employees. In fact, you may act as a sole proprietor under your individual name and tax ID number, so you probably don't have paperwork filed with your local County Clerk's Office.

All that is absolutely, 100 percent fine. One of the benefits of working for yourself is structuring your business the way that best suits you. Moreover, if it weren't for some of those little benefits, the killer self-employment taxes you pay on your earnings each quarter certainly wouldn't be quite as worthwhile.

But there's a line to remember, and it's an important one. The IRS may not be quick to audit you because you use your freelance business account to buy dinner one night, yet this is still a problem. Whether you fear the wrath of your accountant come tax time or not, you should remember to keep your business accounts separate from your personal accounts at all times. Why? I can give you three critical reasons.

Business Charges on Personal Credit Cards

We all do it, especially in the early stage of our business venture. The company doesn't have established credit, so financing goes under your personal credit. We accept this as a necessary evil of business start-ups.

The problems this finance strategy creates can have far-reaching effects. Consider what happens when your business goes under. (I know...I don't want to think about that either because it can never happen to me, but use your imagination.) When a business closes its doors, creditors don't always get the money the business owes. But when you put everything on your personal credit loans and lines? You guessed it. You're personally liable for all that debt, even if you no longer have need for your expensive office equipment or means to pay for it.

Admittedly, that was a dramatic example that may not apply to us as freelance writers or web designers because we can continue to function in our roles unless we encounter the direst of situations. Perhaps whipping out the personal plastic is the only option you have to get the supplies you need for your business. That's ok, as long as you can still separate business and personal charges.

Missing Business Deductions

If the idea of being on the line for all your business expenditures after you close the business doesn't convince you to separate your business and personal accounts, what about the thought of paying the IRS too much money each year? That got your attention, didn't it? I thought it might.

We all know we should keep a log for our business mileage. We know to keep our receipts. We know to record all our business expenses the moment we get back to our computer or manual General Ledger. Unfortunately, what we know and what we do are often polar opposites.

In the best-case scenario, you have separate checking accounts and separate credit cards-even if it's separate personal cards-for business and personal accounts. This makes tax time a snap because we can flip through our business account statements to see all the money we earned and all the money we spent. Piece of cake. April 15^th hasn't been this easy since you first started working for "the man" back in the day.

On the other hand, you're in for a nightmare each spring if you must search multiple credit card and bank statements for the business-related transactions. If you bought business and personal items in the same transaction at a store, good luck proving which portion you can deduct, if you even remember you did that.

Preparing Finances for Making it Big

We've already imagined the demise of our business, but let's look at when the opposite is true. What happens when your little one-man company becomes a sought-after success, requiring you to incorporate the business and hire full-time employees?

Although this is good problem to have, it brings a special brand of stress with it. Suddenly, the IRS cares more about how you handle your books than they did when you were a sole proprietor. A lot more. In fact, failure to keep your books in a manner they deem acceptable spells big audit trouble and even bigger penalties.

Of course, if you've always managed your business funds like, well, a business, the transition from small company to instant success isn't quite as jarring. Who knows, overnight success might even be, dare I say it, fun.